<PAGE>
_______________________________________________________________________________
_______________________________________________________________________________
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10 - Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
- -
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from..................to.......................
COMMISSION FILE NUMBER: 0-26312
TELCOM SEMICONDUCTOR, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3186995
(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
1300 TERRA BELLA, MT. VIEW, CALIFORNIA 94039
(address of principal executive offices)
(Zip Code)
TELEPHONE NUMBER (650) 968-9241
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No
- -
The number of shares outstanding of the registrant's Common Stock as of August
10, 1998 was 16,699,665.
_______________________________________________________________________________
_______________________________________________________________________________
<PAGE>
TELCOM SEMICONDUCTOR, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1998
INDEX
<TABLE>
<CAPTION>
PAGE
NO.
<S> <C>
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations 3
Condensed Consolidated Balance Sheets 4
Condensed Consolidated Statements of Cash Flows 5
Notes To Condensed Consolidated Financial Statements 6-9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10-18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TELCOM SEMICONDUCTOR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
--------------------------------- ----------------------------------
June 30, June 30, June 30, June 30,
1998 1997 1998 1997
--------------- ------------- --------------- -------------
<S> <C> <C> <C> <C>
Net sales $14,023 $13,733 $29,497 $24,856
Cost of sales 8,907 7,681 17,802 14,386
--------------- ------------- --------------- -------------
Gross profit 5,116 6,052 11,695 10,470
--------------- ------------- --------------- -------------
Operating expenses:
Research and development 1,376 1,393 2,691 2,575
Selling, general and administrative 2,757 2,326 5,284 4,387
Loss on foundry investment - - - 8,000
--------------- ------------- --------------- -------------
Total operating expenses 4,133 3,719 7,975 14,962
--------------- ------------- --------------- -------------
Income (loss) from operations 983 2,333 3,720 (4,492)
Interest income (expense), net 116 (95) 212 (269)
--------------- ------------- --------------- -------------
Income (loss) before income taxes 1,099 2,238 3,932 (4,761)
Provision for income taxes 296 604 1,061 875
--------------- ------------- --------------- -------------
Net income (loss) $ 803 $ 1,634 $ 2,871 $(5,636)
=============== ============= =============== =============
Per share data:
Net income (loss)
Basic $ 0.05 $ 0.10 $ .17 $ (0.35)
=============== ============= =============== =============
Diluted $ 0.05 $ 0.10 $ .16 $ (0.35)
=============== ============= =============== =============
Number of shares used to compute per
share data
Basic 16,537 16,113 16,506 16,068
============= =============== =============
Diluted 17,547 16,931 17,632 16,068
=============== ============= =============== =============
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
<PAGE>
TELCOM SEMICONDUCTOR, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
June 30, Dec. 31,
1998 1997
----------------- -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $15,209 $17,110
Marketable securities 3,013 2,469
Accounts receivable 7,916 7,452
Inventory 8,612 8,289
Deferred income taxes 1,167 1,167
Other current assets 570 751
----------------- -----------------
Total current assets 36,487 37,238
Property and equipment, net 16,476 14,946
Other assets 1,500 1,500
----------------- ------------------
$54,463 $53,684
================= ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ 2,373 $ 2,641
Accounts payable 2,689 3,461
Accrued liabilities 1,857 2,460
Deferred distributor income 1,507 1,429
Income taxes payable 2,488 2,566
----------------- -----------------
Total current liabilities 10,914 12,557
Notes payable 2,411 3,462
Deferred income taxes 1,244 1,244
----------------- -----------------
Total liabilities 14,569 17,263
----------------- -----------------
Stockholders' equity:
Common stock 16 16
Additional paid-in capital 34,991 34,389
Notes receivable from stockholders (2) (2)
Retained earnings 4,889 2,018
---------------- -----------------
Total stockholders' equity 39,894 36,421
---------------- -----------------
$54,463 $53,684
================ =================
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
<PAGE>
TELCOM SEMICONDUCTOR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
--------------------------------------------------
June 30,
--------------------------------------------------
1998 1997
--------------------- ---------------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 2,871 $(5,636)
Adjustments to reconcile net income (loss) to net
cash provided by (used for) operating activities:
Impairment loss on foundry investment - 8,000
Depreciation and amortization 2,757 1,929
Changes in assets and liabilities:
Accounts receivable (464) (1,388)
Inventory (323) (626)
Income tax receivable - 1,430
Other current assets 181 85
Accounts payable (772) 1,460
Accrued liabilities (603) 562
Deferred distributor income 78 147
Income taxes payable (78) 560
--------------------- ---------------------
Net cash provided by operating activities 3,647 6,523
--------------------- ---------------------
Cash flows from investing activities:
Purchases of property and equipment (4,287) (2,850)
Sales (purchases) of marketable securities,
net (544) 5,202
--------------------- ---------------------
Net cash provided by (used for) investing activities (4,831) 2,352
--------------------- ---------------------
Cash flows from financing activities:
Proceeds from sale of common stock 602 477
Notes receivable from stockholders - 4
Borrowings on notes payable - 283
Payments on notes payable (1,319) (1,668)
--------------------- ---------------------
Net cash used for financing activities (717) (904)
--------------------- ---------------------
Net increase (decrease) in cash and cash
equivalents (1,901) 7,971
Cash and cash equivalents at the beginning of period 17,110 12,761
--------------------- ---------------------
Cash and equivalents at the end of period $15,209 $20,732
===================== =====================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
TELCOM SEMICONDUCTOR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands)
(Unaudited)
1. The Company and Basis of Presentation:
TelCom Semiconductor, Inc. ("TelCom" or the "Company") designs, develops,
manufactures and markets a diversified portfolio of high performance analog
integrated circuits for use in a wide variety of electronic systems. The Company
operates and reports financial results on a 52-53 week fiscal year ending on the
Friday closest to the last day of December. For convenience, the Company has
presented its fiscal year as ending December 31, and its fiscal quarter as
ending June 30.
In the opinion of management, the unaudited condensed consolidated interim
financial statements have been prepared on the same basis as the December 31,
1997 financial statements and include all adjustments, consisting only of normal
recurring adjustments, necessary to fairly state the information set forth
herein.
This report on Form 10-Q for the period ended June 30, 1998 should be read
in conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 and Form 10-Q for the period ended March 31, 1998.
2. Net Income (Loss) per Share
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") during the fourth quarter of fiscal 1997. This
statement simplifies the standards for computing earnings per share (EPS)
previously defined in Accounting Principles Board Opinion No. 15 "Earnings Per
Share". All prior-period earnings per share data has been restated in accordance
with SFAS 128. SFAS 128 requires presentation of both Basic EPS and Diluted EPS
on the face of the income statement. Basic EPS is computed by dividing net
income available to common stockholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period. Diluted EPS
gives effect to all dilutive potential common shares outstanding during the
period including stock options, using the treasury stock method, and convertible
preferred stock, using the if-converted method. In computing Diluted EPS, the
average stock price for the period is used in determining the number of shares
assumed to be purchased from the exercise of stock options.
6
<PAGE>
Following is a reconciliation of the numerators and denominators of the
Basic and Diluted EPS computations for the periods presented below:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------------------------ -----------------------------------
June 30, June 30, June 30, June 30,
1998 1997 1998 1997
--------------- --------------- --------------- --------------
<S> <C> <C> <C> <C>
Net income (loss) available to
common shareholders $ 803 $ 1,634 $ 2,871 $(5,636)
=============== =============== =============== ==============
Weighted average common stock
outstanding (basic) 16,537 16,113 16,506 16,068
Effect of dilutive warrants and
options 1,010 818 1,126 -
--------------- --------------- --------------- --------------
Weighted average common stock
outstanding (diluted) 17,547 16,931 17,632 16,068
=============== =============== =============== ==============
Income (loss) per share:
Basic $ 0.05 $ 0.10 $ 0.17 $ (0.35)
=============== =============== =============== ==============
Diluted $ 0.05 $ 0.10 $ 0.16 $ (0.35)
=============== =============== =============== ==============
</TABLE>
Options to purchase 126,640 shares of common stock at a weighted average
price of $8.71 per share were outstanding at June 30, 1998 but were not included
in the computation of diluted EPS because the options' exercise price was
greater than the average market price of common stock during the period. Options
to purchase 136,000 shares of common stock at a weighted average price of $6.01
per share were outstanding at June 30, 1997 but were not included in the
computation of diluted EPS for the three months ended June 30, 1997 because the
options' exercise price was greater than the average market price of common
stock during the period. Due to the company's net loss from operations for the
six months ended June 30, 1997, a calculation of EPS assuming dilution is not
required. At June 30, 1997, there were 2,008,126 options and warrants
outstanding to purchase common stock at a weighted average price of $3.17 per
share.
In June 1998, the Company's Board of Directors approved a repricing of
outstanding employee stock options. As a result of the repricing, 934,243
options with exercise prices ranging from $7.00 to $15.94 were exchanged for new
stock options with an exercise price of $4.31 per share.
7
<PAGE>
3. Balance Sheet Details:
<TABLE>
<CAPTION>
June 30, Dec. 31,
1998 1997
------------------ ------------------
<S> <C> <C>
Inventory:
Raw material $ 978 $ 871
Work in process 5,724 4,385
Finished goods 1,910 3,033
------------------ ------------------
$ 8,612 $ 8,289
================== ==================
Property and equipment:
Equipment $ 24,841 $ 20,081
Leasehold improvements 2,737 2,708
------------------ ------------------
27,578 22,789
Accumulated depreciation (12,568) (9,811)
------------------ ------------------
15,010 12,978
Construction in progress 1,466 1,968
------------------ ------------------
$ 16,476 $ 14,946
================== ==================
Accrued liabilities:
Payroll and related $ 1,808 $ 1,667
Customer deposits and other 49 793
------------------ -------------------
$ 1,857 $ 2,460
================== ===================
</TABLE>
4. Loss on Foundry Investment
In November 1995, the Company entered into certain agreements with IC
WORKS, Inc. a privately-held company located in San Jose, California. Pursuant
to these agreements, in 1996 the Company purchased $3.0 million of preferred
stock of IC WORKS and provided $10.4 million in capital equipment. In return for
this investment, TelCom received a guarantee of submicron wafer capacity at
specified prices for a period of five years, projected to start in late 1997.
The shortage of wafer capacity projected in late 1995 has diminished and since
late 1995, substantial foundry capacity has been available worldwide while
overall demand has not increased proportionately. Consequently, wafer pricing
has decreased dramatically, which has changed the economic viability of the
foundry business in which the Company invested. As a result, in the first
quarter of 1997, the Company recorded an impairment loss on its foundry
investment of $8.0 million, consisting of a $3.0 million write down of the
preferred stock and a $5.0 million impairment write down of the equipment. In
the fourth quarter of 1997, pursuant to an agreement with IC WORKS, the Company
sold its $10.4 million of equipment at IC WORKS for $5.2 million and invested an
additional $1.5 million in preferred stock of IC WORKS, Inc. This agreement
terminated the Company's operating agreement with IC WORKS.
8
<PAGE>
5. Subsequent Event
In July 1998, the Company's Board of Directors approved a stock repurchase
program whereby up to 2 million shares of the Company's common stock may be
purchased in the open market from time to time. As of August 12, 1998, 532,500
have been purchased for a total cost of $2.6 million.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Report on Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Actual results could differ materially from
those projected in the forward-looking statements as a result of the risk
related factors set forth herein.
OVERVIEW
TelCom Semiconductor, Inc. ("TelCom" or the "Company") designs, develops,
manufactures and markets a diversified portfolio of high-performance standard
analog integrated circuits for a wide variety of applications in the industrial,
communications, computer, automotive and medical markets. The Company's products
comprise three principal product families: mixed signal products, which are
analog devices with some digital control functionality, such as display
analog/digital converters: power management products, such as switch node power
supply controllers, whose function is to conserve power, and smart sensors, such
as solid state thermal management devices. Within each family, the Company
markets proprietary and selected second source products offering a range of
performance, functionality and price. Average selling prices for the Company's
proprietary products have tended to decline at a slower rate than have those for
the Company's second source products, which are more susceptible to competitive
pricing pressures. The Company generally recognizes higher gross margins on its
proprietary products than on its second source products.
In the third quarter the Company will announce a restructuring plan (the
plan) for the closure of its fabrication facility and termination of certain
employees. As a result of the plan, the Company anticipates incurring charges
for the write down and write off of manufacturing facilities, equipment and
improvements; transfer of its wafer probe operation from its Mountain View,
California facility to its Hong Kong facility; severance of manufacturing and
other personnel and other costs.
The Company plans to shut down its five-inch wafer fabrication facility
in Mountain View, California and use third party foundries for all of its wafer
fabrication. A majority of the Company's new products that have been developed
in the past year utilize sub-micron wafer technology and are currently
fabricated by outside foundries. All other remaining wafers are fabricated in
the Mountain View facility. The fabrication of these wafers will be transferred
to third party foundries during the next six to nine months. The facility
shutdown is a result of developments in the semiconductor industry, primarily
decreasing average selling prices, and the availability of low cost wafer
fabrication capacity. Competitive designs use submicron technology which allows
for more die per wafer than the five inch wafer fabrication currently used in
the Mountain View, California facility. To convert the Mountain View facility to
a six inch submicron facility the Company would be required to make substantial
investments in its facility and equipment over a period of time. By utilizing
wafer foundries with six inch submicron facilities, the Company will be able to
qualify and purchase wafers in a shorter period and at a lower cost. The
majority of the estimated third quarter charge relates to the write down of the
carrying value of the Company's fabrication equipment to estimated fair value.
The fair value of the fabrication equipment is based on third party estimates of
fair value.
The Company's quarterly and annual operating results are affected by a
wide variety of factors that could materially and adversely affect net sales,
gross margins and operating income. These factors include the volume and timing
of orders received, changes in the mix of proprietary and second source products
sold, market acceptance of the Company's and its customers' products,
competitive pricing pressures, the Company's ability to introduce new products
on a timely basis, the timing and extent of research and development expenses,
fluctuations in manufacturing yields, cyclical semiconductor industry
conditions, the Company's access to advanced process technologies and the timing
and extent of process development costs. Historically in the semiconductor
industry, average selling prices of products have decreased over time. If the
Company is unable to introduce new products with higher margins, maintain its
product mix between proprietary and second source products or reduce
manufacturing costs to offset decreases in the prices of its
10
<PAGE>
existing products, the Company's operating results will be adversely affected.
The Company's business is characterized by short term orders and shipment
schedules, and customer orders typically can be canceled or rescheduled without
penalty to the customer. Since most of the Company's backlog is cancelable
without penalty, the Company typically plans its production and inventory levels
based on internal forecasts of customer demand, which is highly unpredictable
and can fluctuate substantially. As a result of the forgoing or other factors,
the Company may experience material adverse fluctuations in future operating
results on a quarterly or annual basis, which would materially and adversely
affect the Company's business, financial condition and results of operations.
In November 1995, the Company entered into certain agreements with IC
WORKS, Inc., a privately-held company located in San Jose, California. Pursuant
to such agreements, the Company purchased $3.0 million of preferred stock of IC
WORKS and provided $10.4 million in capital equipment. In return for this
investment, TelCom received a guarantee of submicron wafer capacity at specified
prices for a period of five years, projected to start in late 1997. The shortage
of wafer capacity projected in late 1995 has diminished and since late 1995,
substantial foundry capacity has been available worldwide while overall demand
has not increased proportionately. Consequently, wafer pricing has decreased
dramatically, which has changed the economic viability of the foundry business
in which the Company invested. As a result, in 1997, the Company recorded a loss
of $8.3 million on its foundry investment which consists of a $3.0 million write
down of the preferred stock, a loss on the sale of the equipment of $5.2
million, and $.1 million of costs associated with prepayment penalties on
financing of the equipment and legal fees. Pursuant to an agreement with IC
WORKS, Inc., in the fourth quarter of 1997, the Company sold its $10.4 million
of equipment at IC WORKS for $5.2 million and invested an additional $1.5
million in preferred stock of IC WORKS, Inc. This agreement terminated the
Company's operating agreement with IC WORKS and final production wafers were
received from IC WORKS in the period ending March 1998. The Company currently is
in the process of qualifying another foundry for future production of submicron
wafers.
RESULTS OF OPERATIONS
NET SALES
Net sales for the three month and six month periods ended June 30, 1998
increased $.3 million or 2.1% and $4.6 million or 18.7%, respectively, from the
corresponding periods in the prior fiscal year. These increases in sales were
primarily due to higher sales volume in the Company's power management product
line. International sales for each of the three month and six month periods
ended June 30, 1998 were 64% of total sales compared to 67% and 65%,
respectively, of total sales for the same periods in the prior year. Sales in
the European market increased in the three month and six month periods ended
June 30, 1998 by $1.0 million, or 27% and $2.8 million, or 36%, respectively,
compared to the three month and six month periods ended June 30, 1997,
primarily due to higher sales of power management products. For the three month
period ended June 30, 1998, three OEM customers, Motorola, Intel and Compaq
Computer, accounted for approximately 34%, 8% and 5%, respectively, of net sales
compared to 29%, 4% and 6%, respectively, of net sales for the same period in
the prior year. In the six month period ended June 30, 1998, Motorola, Intel and
Compaq Computer accounted for approximately 37%, 7% and 5%, respectively, of net
sales compared to 29%, 3% and 6%, respectively, of net sales for the same period
in the prior year. Future Electronics, one of the Company's distributors,
accounted for 11% of the Company's net sales during each of the three month and
six month periods ended June 30,1998 compared to 10% and 11%, respectively, of
net sales for the same periods in the prior year.
GROSS MARGIN
Gross margin as a percentage of sales for the three month and six month
periods ended June 30, 1998 decreased to 36.5% and 39.7%, respectively, from
44.1% and 42.1%, respectively, in the corresponding periods in the prior year.
The decreases in gross margin were caused by lower production volume in the
Company's wafer fabrication facility due to lower wafer starts associated with a
planned inventory reduction program. The Company's ability to increase gross
margins will depend on the successful introduction of its
11
<PAGE>
new proprietary products and controlling its wafer costs. As part of the
Company's restructuring plan, the Company is closing its wafer fabrication
facility and will rely on wafer foundries. Thus, future wafer cost will depend
on the volume and availability from the Company's wafer fabrication foundries.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses for the three month period ended June 30,
1998 was $1.4 million compared to $1.4 million for the corresponding period in
the prior year. Research and development expenses for the six month period ended
June 30, 1998 increased to $2.7 million compared to $2.6 million for the
corresponding period in the prior year. Such expenses as a percent to sales
decreased in the three month and six month periods ending June 30, 1998 to 9.8%
and 9.1% of sales, respectively, from 10.1% and 10.4% of sales, respectively,
for the corresponding periods in the prior year. The Company expects research
and development expenses generally to increase in absolute dollars in future
periods although such expenses may fluctuate as a percentage of net sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the three month and six
month periods ended June 30, 1998 increased to $2.8 million and $5.3 million,
respectively, compared to $2.3 million and $4.4 million for the corresponding
periods in the prior year. These increases were primarily due to increases in
sales personnel, severance cost associated with reducing headcount of 6
employees, and increased advertising costs associated with new products. Such
expenses as a percent of sales increased in the three month and six month
periods ended June 30, 1998 to 19.7% and 17.9% of sales, respectively, compared
to 16.9% and 17.6% of sales for the corresponding periods in the prior year. The
Company expects selling, general and administrative expenses generally to
increase in absolute dollars in future periods although such expenses may
continue to fluctuate as a percentage of net sales.
INTEREST INCOME (EXPENSE), NET
For the three month and six month periods ended June 30, 1998, net interest
income was $116,000 and $212,000, respectively, compared to net interest expense
of $95,000 and $269,000 for the corresponding periods in the prior year. The
increase in net interest income is due to lower interest cost associated with
equipment financing.
INCOME TAXES.
The effective tax rate for the three month period ended June 30, 1998 was
27% consistent with the corresponding period in the prior year. The effective
tax rate for the six month period ended June 30, 1998 was 27%, which reflects a
blended rate of United States, Hong Kong, and German tax rates. This effective
tax rate compares to (18.4%) for the corresponding period in the prior year
which was a result of a tax rate of 27% reflecting the blended rate of the
United States, Hong Kong, and German tax rates, offset by the recording of a
valuation allowance on the income tax benefit of the loss on foundry investment.
LIQUIDITY AND CAPITAL RESOURCES.
As of June 30, 1998, the Company had $18.2 million of cash, cash
equivalents and marketable securities. The Company generated $3.6 million of
cash from operating activities during the six months ended June 30, 1998
primarily reflecting net income of $2.9 million, depreciation of $2.8 million
and a net increase of $2.0 million in working capital items. The net increase in
working capital items primarily reflects an increase in accounts receivable of
$464,000 due to higher sales, and a decrease in current liabilities of $1.4
million, offset by an increase in inventories of $323,000.
12
<PAGE>
The Company utilized $4.8 million of cash from investing activities during
the six months ended June 30, 1998 primarily reflecting the purchase of
production equipment for $4.3 million and the purchase of marketable securities
of $544,000.
At June 30, 1998, the Company had notes payable of $4.8 million, the
proceeds of which were utilized to purchase certain equipment securing such
notes. These notes bear interest ranging from 9% to 13% per annum and are
payable in monthly installments of principal and interest.
The Company believes that its current cash, cash equivalent and marketable
securities balances, together with anticipated cash flow from operations, will
be sufficient to meet the Company's needs for the next twelve months.
The Company is currently planning to shut down its wafer fabrication
facility in Mountain View, California. The planned shut down should take place
within the next 12 months. As a result of the facility shut down, the Company
will utilize third party foundries for all of its wafer fabrication work, which
should result in cost savings due to significantly lower wafer costs. As a
result of the plan, the Company anticipates incurring charges for the write down
and write off of manufacturing facilities, equipment and improvements; transfer
of its wafer probe operation from its Mountain View, California facility to its
Hong Kong facility; severance of manufacturing and other personnel and other
costs. In addition, certain employee severance costs will continue to be
incurred until the facility is fully shut down. The Company currently plans to
continue its back-end manufacturing operations at its Hong Kong facility.
RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes a new model for
accounting for derivatives and hedging activities and supercedes and amends a
number of existing accounting standards. SFAS 133 requires that all derivatives
be recognized in the balance sheet at their fair market value, and the
corresponding derivative gains or losses be either reported in the statement of
operations or as a deferred item depending on the type of hedge relationship
that exists with respect to such derivative. Adopting the provisions of SFAS
133 are not expected to have a material effect on the Company's consolidated
financial statements. The standard is effective for the Company in fiscal 2000.
CERTAIN FACTORS AFFECTING FUTURE RESULTS OF OPERATIONS
The Company's future results of operations are dependent upon a number of
factors, including those described below:
Dependence on New Products. The Company's success depends upon its ability
to develop new analog circuits for existing and new markets, to introduce such
products in a timely manner and to have such products gain market acceptance.
The development of new analog circuits is highly complex and from time to time
the Company has experienced delays in developing and introducing new products.
Successful product development and introduction depends on a number of factors
including proper new product definition, timely completion of design and testing
of new products, achievement of acceptable manufacturing yields and market
acceptance of the Company's and its customers' products. Moreover, successful
product design and development is dependent on the Company's ability to attract,
retain and motivate qualified analog design engineers, of which there is a
limited number. There can be no assurance that the Company will be able to meet
these challenges or adjust to changing market conditions as quickly and cost-
effectively as necessary to compete successfully. Due to the complexity and
variety of analog circuits, the limited number of analog circuit designers and
the limited effectiveness of computer-aided design systems in the design of
analog circuits, there can be no assurance that the Company will be able to
continue to successfully develop and introduce new products on a timely basis.
Although the Company seeks to design products that have the potential to become
industry standard products, there can be no assurance
13
<PAGE>
that any products introduced by the Company will be adopted by such market
leaders, or that any product initially accepted by the Company's customers that
are market leaders will become industry standard products. The Company's failure
to continue to develop and introduce new products successfully could materially
and adversely affect its business and operating results.
The Company's results of operations are dependent on the balance between
sales of relatively higher margin but lower volume proprietary products and
relatively higher volume but lower margin second source products. In order to
improve its margins, sales of proprietary products must in the future represent
a greater percentage of the Company's net revenues, requiring the Company to
successfully develop, introduce and market new proprietary products. There can
be no assurance that the Company will be successful in developing new
proprietary products with the features and functionality that customers in its
key markets will demand.
Increased Dependence On Wafer Suppliers. The Company has historically
obtained at least a majority of it wafers from its own wafer fabrication
facility. Since quarter ended December 1997, the Company has obtained wafers for
a majority of its new products from independent wafer fabrication foundries. The
Company is currently planning to shut down its wafer facility, and, as a result,
within the next twelve months, the Company expects that all of its wafer
requirements will be supplied by outside foundries. There are certain
significant risks associated with the Company's increased reliance on outside
foundries, including the lack of assured wafer supply and control over delivery
schedules, the unavailability of or delay in obtaining access to key process
technologies and limited control over manufacturing yields and production costs.
In addition, the manufacture of integrated circuits is a highly complex and
technically demanding process. Although the Company has undertaken to diversify
its sources of wafer supply and works closely with its foundries to minimize the
likelihood of reduced manufacturing yields, all of the major wafer foundries
have from time to time experienced lower than anticipated manufacturing yields,
particularly in connection with the introduction of new products and the
installation and start-up of new process technologies. Lower than expected
yields at foundries that supply the Company could materially and adversely
affect the Company's operating results. In addition, the Company's reliance upon
offshore foundries will subject the Company to risks of exchange rate
fluctuations, export and import restrictions, trade sanctions, tariff increases
and political instability.
The Company's current and expected purchases of wafers from outside
foundries are pursuant to purchase orders and, accordingly, the Company does not
and will not have a guaranteed level of wafer capacity. Therefore, the Company's
wafer suppliers could choose to prioritize capacity for other uses or reduce or
eliminate deliveries to the Company on short notice. Although there is currently
ample available capacity in the industry, the semiconductor industry is highly
cyclical and in recent years, wafer capacity has been quite scarce. Thus,
particularly in times of scarce capacity, there can be no assurance that the
Company's foundries will allocate sufficient wafer capacity to satisfy the
Company's requirements. Any material disruptions in the supply of wafers to the
Company could materially and adversely affect the Company's operating results.
In the event of any such disruption, if the Company were unable to qualify
alternative manufacturing sources for existing and new products in a timely
manner or if such sources were unable to produce wafers with acceptable
manufacturing yields, the Company's business and operating results would be
materially and adversely affected.
Dependence on New Technologies; Technological Change. The markets for the
Company's products are characterized by rapid technological change and frequent
new product introductions. To remain competitive, the Company must develop or
obtain access to new semiconductor process technologies in order to reduce die
size, increase die performance and functional complexity and improve
manufacturing yields. Semiconductor designs and process methodologies are
subject to rapid technological change, requiring large expenditures for research
and development. If the Company is unable to define, design, develop and
introduce competitive new products on a timely basis, its future operating
results will be materially and adversely affected. In addition, the Company's
ability to compete successfully depends on being able to use advanced analog
process technologies to manufacture its products. There can be no assurance
that the analog process technology utilized by the Company will not become
obsolete.
14
<PAGE>
Intense Competition. The analog semiconductor industry is highly
competitive and subject to rapid technological change. Significant competitive
factors in the analog market include product features, performance, price, the
timing of product introductions, the emergence of new computer standards and
other customer systems, product quality and customer support. Because the
standard products market for analog integrated circuits is diverse and highly
fragmented, the Company encounters different competitors in its various product
markets. The Company's principal competitors include Linear Technology
Corporation, Maxim Integrated Products and Harris Semiconductor in one or more
of its product areas. Other competitors include Motorola, National
Semiconductor Corporation, Unitrode Corporation and certain Japanese
manufacturers. Each of these competitors has substantially greater technical,
financial and marketing resources and greater name recognition than the Company.
The Company expects intensified competition from existing analog circuit
suppliers and the possible entry of new competition. Increased competition
could adversely affect the Company's financial condition or results of
operations. There can be no assurance that the Company will be able to compete
successfully in the future or that competitive pressures will not adversely
affect the Company's financial condition and results of operations. Competitive
pressures could reduce market acceptance of the Company's products and result in
price reductions and increases in expenses that could adversely affect the
Company's financial condition or results of operations.
Dependence on International Sales and Operations. International sales for
each of the three month and six month periods ended June 30, 1998 were 64% of
total sales compared to 67% and 65%, respectively, of total sales for the same
periods in the prior year. The Company expects international sales to continue
to represent a significant portion of product sales. International sales and
operations involve various risks, including unexpected changes in regulatory
requirements, delays resulting from difficulty in obtaining export licenses for
certain technology, tariffs and other barriers and restrictions, and the burdens
of complying with a variety of foreign laws. The Company is also subject to
general political risks in connection with its international operations, such as
political and economic instability and changes in diplomatic and trade
relationships. In addition, because a substantial majority of the Company's
international sales are denominated in United States dollars, increases in the
value of the dollar would increase the price in local currencies of the
Company's products in foreign markets and make the Company's products relatively
more expensive than competitors' products, the sales of which are denominated in
local currencies. There can be no assurance that regulatory, political and
other factors will not adversely affect the Company's operations in the future
or require the Company to modify its current business practices.
Customer and Distributor Concentration. A limited number of customers and
distributors has accounted for a significant portion of the Company's net sales.
For the three month period ended June 30, 1998, three OEM customers, Motorola,
Intel and Compaq Computer, accounted for approximately 34%, 8% and 5%,
respectively, of net sales compared to 29%, 4% and 6%, respectively, of net
sales for the same period in the prior year. In the six month period ended June
30, 1998, Motorola, Intel and Compaq Computer accounted for approximately 37%,
7% and 5%, respectively, of net sales compared to 29%, 3% and 6%, respectively,
of net sales for the same period in the prior year. Future Electronics, one of
the Company's distributors, accounted for 11% of the Company's net sales during
each of the three month and six month periods ended June 30, 1998 compared to
10% and 11%, respectively, of net sales for each of the same periods in the
prior year. The Company anticipates that it will continue to be dependent or may
increase its dependence on a number of key customers and distributors for a
significant portion of its net sales. The reduction, delay or cancellation of
orders from one or more significant customers for any reason would materially
and adversely affect the Company's operating results. The Company is also
dependent on sales representatives and distributors for the sale of its products
to many of its customers. Such distributors also sell competitors' products and
are not within the control of the Company. Loss of one or more of the Company's
current distributors or disruption of the Company's sales and distribution
channels could materially and adversely affect the Company's business and
operating results.
Dependence on Key Suppliers; Outsourcing of Assembly Operations. The
packaging of the Company's products is performed by a limited group of
subcontractors and certain of the raw materials included in such products are
obtained from a limited group of suppliers. Although the Company seeks to
15
<PAGE>
reduce its dependence on its sole and limited source suppliers, disruption or
termination of any of these sources could occur and such disruptions could have
a material adverse effect on the Company's financial condition or results of
operations. Moreover, a prolonged inability to obtain raw materials could have a
material adverse effect on the Company's financial condition or results of
operations and could result in damage to customer relationships.
The Company currently depends on third party subcontractors for all of its
assembly and a significant portion of its wafer fabrication needs. In connection
with its restructuring, the Company will rely on foundries for all of its future
wafer requirements. In the event that any of the Company's foundries or
subcontractors were to experience financial, operational, production or quality
assurance difficulties resulting in a reduction or interruption in supply to the
Company, the Company's operating results would be adversely affected until
alternative foundries or subcontractors, if any, became available.
Patents and Intellectual Property. The Company's success depends in part
in its ability to obtain patents and licenses and to preserve other intellectual
property rights covering its manufacturing processes, products and development
and testing tools. The Company seeks patent protection for those inventions and
technologies for which it believes such protection is suitable and is likely to
provide a competitive advantage to the Company. The process of seeking patent
protection can be long and expensive and there can be no assurance that its
current patents or any new patents that may be issued will be of sufficient
scope or strength to provide any meaningful protection or any commercial
advantage to the Company. The Company may in the future be subject to or
initiate interference proceedings in the United States Patent and Trademark
office, which can demand significant financial and management resources.
The Company regards elements of its product design and equipment as
proprietary and seeks to protect its proprietary rights through a combination of
employee and third party non-disclosure agreements, internal procedures and
patent protection. Notwithstanding the Company's attempts to protect its
proprietary rights, the Company believes that its future success will depend
primarily upon the technical expertise, creative skills and management abilities
of its officers and key employees rather than on patent and copyright ownership.
The Company also relies substantially on trade secrets and proprietary
technology to protect technology and manufacturing know-how, and works actively
to foster continuing technological innovation to maintain and protect its
competitive position. There can be no assurance that the Company's competitors
will not independently develop or patent substantially equivalent or superior
technologies.
Although the Company is not currently a party to any material litigation,
the semiconductor industry is characterized by frequent litigation regarding
patent and other intellectual property rights. There can be no assurance that
any patent owned by the Company will not be invalidated, circumvented or
challenged, that the rights granted thereunder will provide competitive
advantages to the Company or that any of the Company's pending or future patent
applications will be issued with the scope of the claims sought by the Company,
if at all. In addition, effective copyright and trade secret protection may be
unavailable or limited in certain foreign countries.
As is typical in the semiconductor industry, the Company has from time to
time received, and may in the future receive, communications from third parties
asserting patents, mask work rights, or copyrights on certain of the Company's
products and technologies. Although the Company is not currently a party to any
material litigation, in the event a third party were to make a valid
intellectual property claim and a license was not available on commercially
reasonable terms, the Company's operating results could be materially and
adversely affected. Litigation, which could result in substantial cost to the
Company and diversion of its resources, may also be necessary to enforce patents
or other intellectual property rights of the Company or to defend the Company
against claimed infringement of the rights of others. The failure to obtain
necessary licenses or the occurrence of litigation relating to patent
infringement or other intellectual property matters could have a material
adverse effect on the Company's business and operating results. There can be no
assurance that the steps taken by the Company to protect its intellectual
property will be adequate to prevent misappropriation or that others will not
develop competitive technologies or products.
16
<PAGE>
Environmental and Other Governmental Regulations. Federal, state and local
regulations impose various controls on the storage, handling, discharge and
disposal of chemicals and gases used in the Company's manufacturing process and
on the facility leased by the Company in Mountain View, California. The Company
believes that its activities conform to present governmental regulations
applicable to its operations and its current facilities including those related
to environmental, land use, public utility utilization and fire code matters.
Increasing public attention has, however, been focused on the environmental
impact of semiconductor operations and the risk to neighbors of chemical
releases from such operations. There can be no assurance that such governmental
regulations will not in the future impose the need for additional capital
equipment or other process requirements upon the Company or restrict the
Company's ability to expand its operations. In this regard, the City of
Mountain View, where the Company's wafer fabrication facility is located,
adopted an ordinance which restricts the storage and use of hazardous materials
within the proximity of certain sensitive uses, including hospitals, day care
facilities and schools. Although the Company's operations have not been
adversely affected by the ordinance, there can be no assurance that this
ordinance will not materially adversely affect the Company's future operations.
The adoption of this ordinance or similar measures or any failure by the Company
to comply with applicable environmental and land use regulations or to restrict
the discharge of hazardous substance could subject the Company to future
liability or could cause its manufacturing operations to be curtailed or
suspended.
The Company acquired the semiconductor manufacturing operations of
Teledyne, Inc. previously conducted at the Company's facility. The
semiconductor manufacturing operations conducted by Teledyne at the facility
allegedly contaminated the soil and groundwater of the facility and the
groundwater of properties located down-gradient of the facility. Although the
Company was indemnified by Teledyne as part of the acquisition transaction
against, among other things, any liabilities arising from any such
contamination, there can be no assurance that claims will not be made against
the Company or that such indemnification will be available or will provide
meaningful protection at the time any such claim is brought. To the extent the
Company is subject to a claim which is not covered by the indemnity from
Teledyne or as to which Teledyne is unable to provide indemnification, the
Company's financial condition or results of operations could be materially and
adversely affected.
Semiconductor Industry. The semiconductor industry is characterized by
rapid technological change, cyclical market patterns, significant price erosion,
periods of over-capacity and production shortages, variations in manufacturing
costs and yields and significant expenditures for capital equipment and product
development. The industry has from time to time experienced depressed business
conditions. There can be no assurance that any future downturn in the industry
will not be severe or that any such downturn will not have a material adverse
effect on the Company's results of operations. There can be no assurance that
the Company will not experience substantial period-to-period fluctuations in
operating costs due to general semiconductor industry conditions or other
factors.
Year 2000 Issues. There is a risk to the Company from unforeseen problems
related to the "Year 2000 issue." The "Year 2000" issue arises because most
computer systems and programs were designed to handle only a two-digit year, not
a four-digit year. When Year 2000 begins, these computers may interpret "00" as
the year 1900 and could either stop processing date related computations or
could process them incorrectly. The Company has completed an assessment of its
information systems and does not anticipate any internal material Year 2000
issues from its own information systems, databases or programs. Certain software
packages are currently being upgraded to compliant versions. The costs incurred
to date and expected in the future are not material to the Company's financial
condition or results of operations. However, the Company could be adversely
impacted by Year 2000 issues faced by major distributors, suppliers, customers,
vendors, and financial organizations with which the Company interacts. The
Company is in the process of determining the impact that third parties who are
not Year 2000 compliant may have on the operations of the Company. Non
compliance by any of the Company's major distributors, suppliers, customers,
vendors, or financial organizations could result in business disruptions that
could have a material adverse affect on the Company's consolidated results of
operations, liquidity and financial condition. Being that the Company has not
completed an assessment of significant third party compliance, contingency plans
have not been developed. Upon completion of the assessment, a contingency plan
will be developed to
17
<PAGE>
minimize the Company's exposure to work slowdowns or business disruptions and
adverse affects on the Company's results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Disclosure.
Interest Rate Risk - The Company does not use derivative financial
instruments in its investment portfolio. The Company's investment portfolio is
generally comprised of municipal government securities that mature within one
year. The Company places investments in instruments that meet high credit
quality standards. These securities are subject to interest rate risk, and could
decline in value if interest rates fluctuate. Due to the short duration and
conservative nature of the Company's investment portfolio, the Company does not
expect any material loss with respect to its investment portfolio.
Foreign Currency Exchange Rate Risk - Certain of the Company's sales, cost
of manufacturing and marketing are transacted in local currencies. As a result,
the Company's international results of operations are subject to foreign
exchange rate fluctuations. The Company does not currently hedge against foreign
currency rate fluctuations. Gains and losses from such fluctuations have not
been material to the Company's consolidated results of operations.
18
<PAGE>
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
Registrant held its Annual Meeting of Shareholders on April 16, 1998.
At the meeting the following matters were voted upon, and the number of
votes cast for and against, as well as the number of abstentions and broker non
votes, as to each such matter, along with a separate tabulation with respect to
each nominee for office, is set forth below:
1. Election of directors to serve for the ensuing year and until their
successors are duly elected and qualified.
<TABLE>
<CAPTION>
For Against Abstention Non Votes
------------------ --------------- ----------------- --------------------
<S> <C> <C> <C> <C>
Phillip M. Drayer 13,859,363 0 754,056 0
T. Peter Thomas 13,860,113 0 753,306 0
Donald E. Fowler 13,858,963 0 754,456 0
Frank Gill 13,858,513 0 754,906 0
R. Michael O'Malley 13,861,913 0 751,506 0
</TABLE>
2. Approval of amendment to 1994 Stock Option Plan
<TABLE>
<CAPTION>
For Against Abstention Non Votes
------------------ --------------- ----------------- --------------------
<S> <C> <C> <C> <C>
7,707,959 1,740,974 19,716 0
</TABLE>
3. Approval of Amendment to Employee Stock Purchase Plan
<TABLE>
<CAPTION>
For Against Abstention Non Votes
------------------ --------------- ----------------- --------------------
<S> <C> <C> <C>
8,906,127 584,402 20,485 0
</TABLE>
4. Ratification of the appointment of PricewaterhouseCoopers LLP as the
Company's independent accountants for the current fiscal year ending
December 31, 1998.
<TABLE>
<CAPTION>
For Against Abstention Non Votes
------------------ --------------- ----------------- --------------------
<S> <C> <C> <C>
14,598,462 8,557 6,400 0
</TABLE>
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are being filed as part of this report.
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the fiscal quarter for
which this report is filed.
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TELCOM SEMICONDUCTOR, INC.
(Registrant)
Date: August 13, 1998 By: /s/ Phillip M. Drayer
----------------------------------
Phillip M. Drayer
President
Chief Executive Officer
Date: August 13, 1998 By: /s/ Robert G. Gargus
----------------------------------
Robert G. Gargus
Chief Financial Officer
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 15,209
<SECURITIES> 3,013
<RECEIVABLES> 8,111
<ALLOWANCES> 195
<INVENTORY> 8,612
<CURRENT-ASSETS> 36,487
<PP&E> 29,044
<DEPRECIATION> 12,568
<TOTAL-ASSETS> 54,463
<CURRENT-LIABILITIES> 10,914
<BONDS> 0
0
0
<COMMON> 16
<OTHER-SE> 34,991
<TOTAL-LIABILITY-AND-EQUITY> 54,463
<SALES> 29,497
<TOTAL-REVENUES> 29,497
<CGS> 17,802
<TOTAL-COSTS> 25,777
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 212
<INCOME-PRETAX> 3,932
<INCOME-TAX> 1,061
<INCOME-CONTINUING> 2,871
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,871
<EPS-PRIMARY> 0.17
<EPS-DILUTED> 0.16
</TABLE>
